For those who recall this phrase from a decade ago, it must conjure images of the 2008 financial crisis and the catastrophic failure of some of the largest multinational financial institutions across the globe, thought at the time to be “too big to fail”. With the benefit of hindsight, the acquired wisdom today is that no institution is too big to fail.
The phrase “too big to fail” is once again in current use, albeit in a related but different context. Today “too big to fail” is used informally to refer to systemically important financial institutions (SIFI) or systemically important banks (SIB). Such institutions include banks whose failure might trigger another financial crisis within their own economy with the increasingly present risk of contagion and possibility of triggering another global crisis similar to that of 2008.
Today, “too big to fail” does not mean that they cannot fail; we know they can. This means that national and supranational regulatory authorities have determined that such banks cannot be allowed to fail.
In the aftermath of the 2008 global crisis, some national governments took it upon themselves to intervene and ‘bail out’ some (but not all) of these institutions by injecting huge amounts of taxpayer monies to save some banks from certain failure. This is not the approach that is being postulated today.
Today when national and supranational regulatory authorities consider that a particular bank is “too big to fail”, it means that the activities of such a bank will be closely supervised in an intrusive manner. If deemed necessary and in the interest of financial stability, regulators will direct particular banks to take corrective action they deem appropriate to address specific or potential risks that a bank may be carrying or which it may be exposed to in future.
A bank is classified as an SIB following an analysis of various factors for assessing whether it is, in fact, systemically important either to its own economy or even to the wider global banking system. These factors include the size of the bank relative to its domestic economy, its complexity, its interconnectedness, the lack of readily available substitutes for the financial infrastructure it provides, as well as its cross-jurisdictional transactions.
The MFSA and the Central Bank of Malta identified three Maltese banks as systemically important credit institutions: BOV, HSBC and Medirect Bank (Malta) plc
Following on from the 2008 crisis, Basel III specifically targeted SIBs by focusing regulations to force a significant increase in their capital requirements. As a direct result, regulation imposes upon SIBs to hold additional capital to mitigate the vulnerability of its domestic financial system and consequently the real national economy.
In the event of potential failure or impairment, such an institution would be able to fall back on the additional capital as a loss absorbing cushion in order to ensure that it poses minimal risk to depositors, shareholders and the national economy. Certain business activities undertaken by banks and other institutions, which are deemed to carry a higher level of risk, will attract even higher capital requirements.
Hence, this additional capital requirement not only limits certain business activities but will invariably result in lower potential profits for such institutions.
The possible losses which these capital buffers aim to address are mainly related to what is considered excessive risk-taking by such large institutions as had occurred in the run-up of the 2008 crisis.
Such risks include: credit risks of lending which defaults; market risks of securities held by SIBs; operational risks of day to day activities going awry; the moral hazard of excessive risk taking; liquidity risk of not being able to meet requests for withdrawals; business risk of failure of certain business activities; reputational risk as well as systemic risks triggered by other institutions to which the bank is connected.
The MFSA and the Central Bank of Malta, in consultation with the European Central Bank, have identified three Maltese banks as systemically important credit institutions, these being: Bank of Valletta plc (BOV), HSBC Bank Malta plc and Medirect Bank (Malta) plc.
In an ongoing process, BOV has been gradually increasing its capital buffers for a good number of years now and is within its regulatory requirements.
As BOV continues to review and update its risk management framework, it is actively monitoring the various risks and pruning its business accordingly. BOV has articulated its risk appetite and a commensurate customer acceptance policy.
In other words, moving forward BOV will seek to grow by engaging in new business involving lower risk transactions and lower risk business models. Furthermore, BOV is also reviewing its legacy business, discontinuing certain services and also terminating specific corporate and personal relationships involving transactions falling outside its revised risk appetite as a systemically important credit institution.
This will invariably bring some pains in the short-terms which are unavoidable in a de-rising process. These initiatives may be seen as running contrary to the specific interests of established or budding niche markets. However, they are ultimately in the long term interest of the stability and sustainability of each systemically important credit institution, its depositors, shareholders and stakeholders, as well as the long term health of the wider national economy and Malta as a financial jurisdiction.
Joseph Camilleri has held a number of senior key executive positions spanning a 32 year career at Bank of Valletta; he is currently the chief officer responsible for international business, as well as the Bank’s business restructuring initiatives.